The political storm unfolding between the UK and Europe brings is not a pretty one for investors.
EU officials warn that negotiations are not progressing well; the EU ‘divorce bill’ could amount to billions of pounds – the latest reports speculate £50 billion – and there is still uncertainty over trade, worker rights, health care, immigration, the single market and customs union.
Meanwhile the government has no majority and looks to face real problems in getting legislation through Parliament.
Apart from that it’s all going really well.
So how do you create a Brexit-proof portfolio with passive investments?
A sterling performance
Much depends on your view of sterling. Unless you think the beleaguered pound is going to tank further, the best approach may be to stock up on currency hedged pan-European equities and reduce government bond duration in the run-up to Brexit.
Allan Lane, managing partner of Twenty20 Investments, is predicting a ‘hard Brexit’ but thinks this would lead to a friendlier relationship between the UK and the EU and a relief rally in capital markets.
‘So much so, that pan-European growth will be the order of the day, along with the strengthening of sterling,’ he said.
Two diversified ETF options here are the newly-launched UBS MSCI Europe UCITS ETF (hedged to GBP) at 0.30% fees or the Lyxor EURO STOXX 300 GBP Monthly Hedged UCITS ETF at 0.15%.
The Lyxor fund is up 18.9% over one year in sterling terms, versus returns of around 11-12% for FTSE 100 ETFs over the same period.
James King, managing director of PB Financial Planning, agrees that UK bond and equity markets appeared relatively unattractive compared to Europe, US, Asia and emerging markets. Unlike Lane, however, he is betting on a ‘soft Brexit’.
‘Investors should reduce bond duration and invest in a highly diversified basket of equity markets outside of the UK,’ he said.
‘Sterling is undervalued and the risk lies to the upside for a steep appreciation following the inevitable route to a soft Brexit and rate increases by the Bank of England, whenever they may be.’
But Adam Laird, head of ETF strategy, Northern Europe, Lyxor ETF, argues that UK gilts still hold value in terms of protecting investors, and that interest rate hikes, which could knock bond markets, might not happen for several years.
‘This isn’t an obvious choice as the split [with the EU] is likely to put stress on the British economy,’ he said.
‘The cost of exit, barriers to import and export – these factors will put pressure on government debt. But the UK has never outright defaulted on its debt.’
The cheapest gilt ETF on the UK market is the Lyxor FTSE Actuaries UK Gilts UCITS ETF with fees of 0.07%.
As King advises to focus on shorter-dated debt, one option is the Lyxor FTSE Actuaries UK Gilts 0-5Y UCITS ETF for the same price. The funds are up 2.6% and 0.3% respectively year to date.
No holiday for shares
As for UK equities, again it comes down to your view of the pound.
While King said investors should reduce their investment in FTSE 100 and 250 ETFs, Laird said the continually low currency could boost their appeal.
The pound has tanked from $1.49 before the referendum in June 2016 to $1.30, and the €1.30 to €1.09. Neither rate show immediate signs of a strong rebound.
‘Whilst this is bad for holiday makers, it’s good for exporting firms – which typically means blue chip shares,’ said Laird.
The cheapest and most liquid option is the iShares Core FTSE 100 UCITS ETF for just 0.07%; the fund is up year to date more than 7%.
In times of uncertainty, gold also tends to rise and always acts as a portfolio diversifier and is up from $1,150 in early 2017 to around $1,339 this year. The ETFS Physical Gold is up more than 15% year to date and costs 0.39%.
‘With Brexit, the choice of ETF really depends on if investors see it as a risk or an opportunity,’ said Laird.